UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 1999
---------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from_______________ to ______________
Commission File Number: 0-10956
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EMC INSURANCE GROUP INC.
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(Exact name of registrant as specified in its charter)
Iowa 42-6234555
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
717 Mulberry Street, Des Moines, Iowa 50309
- --------------------------------------- ------------------
(Address of principal executive office) (Zip Code)
(515) 280-2902
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at April 30, 1999
----- -----------------------------
Common stock, $1.00 par value 11,301,748
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Total pages 19
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<PAGE>
PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements
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EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, December 31,
1999 1998
------------ ------------
ASSETS
Investments:
Fixed maturities:
Securities held-to-maturity, at amortized cost
(fair value $175,735,444 and $174,623,439) $165,018,119 $164,926,190
Securities available-for-sale, at fair value
(amortized cost $209,714,431 and
$208,115,127) .............................. 217,206,384 217,499,600
Equity securities available-for-sale, at fair
value (cost $30,221,981 and $29,928,433) ..... 31,854,245 32,785,429
Short-term investments, at cost ................ 25,500,378 22,660,011
------------ ------------
Total investments ..................... 439,579,126 437,871,230
Cash ............................................. 1,219,682 2,133,056
Accrued investment income ........................ 6,280,772 5,865,307
Accounts receivable (net of allowance for
uncollectible accounts of $500,000 and $400,000) 3,155,162 2,779,041
Income tax recoverable ........................... 660,000 3,224,000
Reinsurance receivables .......................... 17,185,736 16,627,791
Deferred policy acquisition costs ................ 12,397,747 12,355,482
Deferred income taxes ............................ 11,655,010 10,371,754
Intangible assets, including goodwill, at cost
less accumulated amortization of $2,246,323
and $2,212,695 ................................. 1,311,497 1,345,125
Prepaid reinsurance premiums ..................... 1,186,513 1,201,737
Other assets ..................................... 3,412,230 2,271,829
------------ ------------
Total assets .......................... $498,043,475 $496,046,352
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Balance Sheets
March 31, December 31,
1999 1998
------------ ------------
LIABILITIES
Losses and settlement expenses ................... $249,215,264 $245,610,323
Unearned premiums ................................ 61,024,651 61,464,051
Other policyholders' funds ....................... 1,793,390 1,951,683
Indebtedness to related party .................... 6,532,427 3,393,182
Postretirement benefits .......................... 6,223,185 6,017,565
Deferred income .................................. 243,649 277,854
Other liabilities ................................ 11,359,373 13,393,854
------------ ------------
Total liabilities ......................... 336,391,939 332,108,512
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, authorized 20,000,000
shares; issued and outstanding, 11,470,548
shares in 1999 and 11,496,389 shares in 1998 ... 11,470,548 11,496,389
Additional paid-in capital ....................... 67,561,695 67,822,412
Accumulated other comprehensive income ........... 6,021,982 8,079,371
Retained earnings ................................ 76,597,311 76,539,668
------------ ------------
Total stockholders' equity ................ 161,651,536 163,937,840
------------ ------------
Total liabilities and stockholders' equity $498,043,475 $496,046,352
============ ============
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Income
Three months ended
March 31,
------------------------
1999 1998
----------- -----------
REVENUES:
Premiums earned .................................. $49,744,614 $45,688,223
Investment income, net ........................... 6,269,253 6,294,161
Realized investment gains ........................ 89,288 89,165
Other income ..................................... 769,077 229,591
----------- -----------
56,872,232 52,301,140
----------- -----------
LOSSES AND EXPENSES:
Losses and settlement expenses ................... 38,466,995 30,390,250
Dividends to policyholders ....................... 472,189 1,002,339
Amortization of deferred policy acquisition costs 11,735,899 9,127,619
Other underwriting expenses ...................... 4,140,342 5,531,764
Other expenses ................................... 484,290 235,841
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55,299,715 46,287,813
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Income before income taxes ................. 1,572,517 6,013,327
----------- -----------
INCOME TAXES (BENEFIT):
Current .......................................... 14,164 1,885,000
Deferred ......................................... (223,390) (350,307)
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(209,226) 1,534,693
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Net income ................................. $ 1,781,743 $ 4,478,634
=========== ===========
Net income per common share - basic and diluted .... $ .15 $ .39
=========== ===========
Dividends per common share ......................... $ .15 $ .15
=========== ===========
Average number of shares outstanding - basic and
diluted .......................................... 11,496,312 11,356,381
=========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
Three months ended
March 31,
------------------------
1999 1998
----------- -----------
Net income ......................................... $ 1,781,743 $ 4,478,634
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OTHER COMPREHENSIVE INCOME:
Unrealized holding (losses) gains arising during
the period, before deferred income taxes
(benefit) ...................................... (3,027,966) 2,958,014
Deferred income taxes (benefit) .................. (1,029,507) 1,005,725
----------- -----------
(1,998,459) 1,952,289
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Reclassification adjustment for gains included
in net income, before income taxes ............. (89,288) (84,749)
Income taxes ..................................... 30,358 28,815
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(58,930) (55,934)
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Other comprehensive (loss) income .......... (2,057,389) 1,896,355
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Total comprehensive (loss) income .......... $ (275,646) $ 6,374,989
=========== ===========
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three months ended
March 31,
--------------------------
1999 1998
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................... $ 1,781,743 $ 4,478,634
------------ ------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Losses and settlement expenses ............ 3,604,941 1,975,325
Unearned premiums ......................... (439,400) (1,010,795)
Other policyholders' funds ................ (158,293) 364,599
Deferred policy acquisition costs ......... (42,265) (1,179,698)
Indebtedness of related party ............. 3,139,245 3,124,947
Accrued investment income ................. (415,465) (26,370)
Income taxes payable ...................... 2,564,000 (933,000)
Deferred income taxes ..................... (223,390) (350,306)
Realized investment gains ................. (89,288) (89,165)
Postretirement benefits ................... 205,620 236,727
Reinsurance receivables ................... (557,945) (757,914)
Prepaid reinsurance premiums .............. 15,224 579
Amortization of deferred income ........... (34,205) (46,912)
Other, net ................................ (3,545,085) (1,176,852)
------------ ------------
4,023,694 131,165
Cash provided by the change in the
property and casualty insurance
subsidiaries' pooling agreement (note 2) - 5,569,567
------------ ------------
Net cash provided by
operating activities .............. $ 5,805,437 $ 10,179,366
------------ ------------
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Three months ended
March 31,
--------------------------
1999 1998
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed maturity securities
held-to-maturity ............................ $ (5,975,625) $ (2,500,000)
Maturities of fixed maturity securities
held-to-maturity ............................ 5,903,518 3,893,187
Purchases of fixed maturity securities
available-for-sale .......................... (16,194,529) (6,025,815)
Disposals of fixed maturity securities
available-for-sale .......................... 14,605,213 8,951,500
Purchases of equity securities
available-for-sale .......................... (7,243,414) (500,000)
Disposals of equity securities
available-for-sale .......................... 7,037,052 977,233
Net purchases of short-term investments ....... (2,840,368) (13,321,093)
------------ ------------
Net cash used in investing activities ..... (4,708,153) (8,524,988)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock ...................... 154,827 57,675
Repurchase of common stock (note 4) ........... (441,385) -
Dividends paid to stockholders ................ (1,724,100) (1,091,503)
------------ ------------
Net cash used in financing activities ..... (2,010,658) (1,033,828)
------------ ------------
NET (DECREASE) INCREASE IN CASH ................. (913,374) 620,550
Cash at beginning of year ....................... 2,133,056 1,200,300
------------ ------------
Cash at end of quarter .......................... $ 1,219,682 $ 1,820,850
============ ============
Income taxes (recovered) paid ................... $ (2,550,000) $ 2,818,000
See accompanying Notes to Interim Consolidated Financial Statements.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements
March 31, 1999
Note 1
- ------
The results of operations for the interim periods reported are not necessarily
indicative of results to be expected for the year. The information reflects
all adjustments which are, in the opinion of management, necessary for a fair
statement of the results for the interim periods.
Certain amounts previously reported in prior years' consolidated financial
statements have been reclassified to conform to current year presentation.
In reading these financial statements, reference should be made to the
Company's 1998 Form 10-K or the 1998 Annual Report to Shareholders for more
detailed footnote information.
Note 2
- ------
Effective January 1, 1998, Farm and City Insurance Company (Farm and City), a
subsidiary of the Company that writes nonstandard risk automobile insurance
business, became a participant in the EMC Insurance Companies pooling
agreement. Farm and City assumes a 1.5 percent participation in the pool,
which increased the Company's aggregate participation in the pool from 22
percent to 23.5 percent. In connection with this change in the pooling
agreement, the Company's liabilities increased $6,224,586 and invested assets
increased $5,569,567. The Company reimbursed Employers Mutual Casualty
Company (Employers Mutual) $726,509 for the expenses that were incurred to
generate the additional business assumed by the Company and Employers Mutual
paid the Company $71,490 in interest income as the actual cash transfer did
not occur until March 25, 1998.
Note 3
- ------
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) 133, "Accounting for Derivative
Instruments and Hedging Activities", which is effective for fiscal years
beginning after June 15, 1999. Currently, the Company's investment strategy
does not include investments in derivative instruments or hedging activities.
Adoption of this statement is not expected to have any effect on the operating
results of the Company.
Note 4
- ------
On November 20, 1998, the Company's Board of Directors approved a stock
repurchase plan for up to $3,000,000 of the Company's common stock. The
repurchase plan authorizes the Company to make repurchases in the open market
or through privately negotiated transactions. The timing and terms of the
purchases will be determined by management based on market conditions and will
be conducted in accordance with the applicable rules of the Securities and
Exchange Commission. The plan may be terminated at any time at the Company's
discretion. During the first quarter of 1999, the Company repurchased 39,050
shares of common stock at an average price per share of $11.30.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations
-----------------------------------
OVERVIEW
EMC Insurance Group Inc., an approximately 68 percent owned subsidiary of
Employers Mutual Casualty Company (Employers Mutual), is an insurance holding
company with operations in property and casualty insurance and reinsurance.
Property and casualty insurance is the most significant segment, representing
79.9 percent of consolidated premiums earned. For purposes of this
discussion, the term "Company" is used interchangeably to describe EMC
Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and
its subsidiaries.
The Company's four property and casualty insurance subsidiaries and two
subsidiaries and an affiliate of Employers Mutual are parties to reinsurance
pooling agreements with Employers Mutual (collectively the "pooling
agreement"). Under the terms of the pooling agreement, each company cedes to
Employers Mutual all of its insurance business, with the exception of any
voluntary reinsurance business assumed from nonaffiliated insurance companies,
and assumes from Employers Mutual an amount equal to its participation in the
pool. All losses, settlement expenses and other underwriting and
administrative expenses, excluding the voluntary reinsurance business assumed
by Employers Mutual from nonaffiliated insurance companies, are prorated among
the parties on the basis of participation in the pool. Operations of the pool
give rise to intercompany balances with Employers Mutual, which are settled on
a quarterly basis. The investment and income tax activities of the pool
participants are not subject to the pooling agreement.
The purpose of the pooling agreement is to spread the risk of an exposure
insured by any of the pool participants among all the companies. The pooling
agreement produces a more uniform and stable underwriting result from year to
year for all companies in the pool than might be experienced individually. In
addition, each company benefits from the capacity of the entire pool, rather
than being limited to policy exposures of a size commensurate with its own
assets, and from the wide range of policy forms, lines of insurance written,
rate filings and commission plans offered by each of the companies. A single
set of reinsurance treaties is maintained for the protection of all companies
in the pool.
The Company's reinsurance subsidiary assumes a 100 percent quota share
portion of Employers Mutual's assumed reinsurance business, exclusive of
certain reinsurance contracts. This includes all premiums and related losses
and settlement expenses of this business, subject to a maximum loss of
$1,500,000 per event. The reinsurance subsidiary does not reinsure any of
Employers Mutual's direct insurance business, nor any "involuntary" facility
or pool business that Employers Mutual assumes pursuant to state law. In
addition, the reinsurance subsidiary is not liable for credit risk in
connection with the insolvency of any reinsurers of Employers Mutual.
Operations of the quota share agreement give rise to intercompany balances
with Employers Mutual, which are settled on a quarterly basis.
The results of operations for the interim periods reported are not
necessarily indicative of results to be expected for the year. The
information reflects all adjustments which are, in the opinion of management,
necessary for a fair statement of the results for the interim periods.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
CONSOLIDATED RESULTS OF OPERATIONS
Operating results for the three months ended March 31, 1999 and 1998 are
as follows:
($ in thousands) 1999 1998
-------- --------
Premiums earned .......................... $ 49,745 $ 45,688
Losses and settlement expenses ........... 38,467 30,390
Acquisition and other expenses ........... 16,348 15,662
-------- --------
Underwriting loss ........................ (5,070) (364)
Net investment income .................... 6,269 6,294
Other income (loss) ...................... 285 (6)
-------- --------
Operating income before income taxes ..... 1,484 5,924
Realized investment gains ................ 89 89
-------- --------
Income before income taxes ............... $ 1,573 $ 6,013
======== ========
Incurred losses and settlement expenses:
Insured events of the current year ..... $ 39,329 $ 34,768
Decrease in provision for insured
events of prior years ................ (862) (4,378)
-------- --------
Total losses and settlement expenses $ 38,467 $ 30,390
======== ========
Catastrophe and storm losses ............. $ 1,860 $ 519
======== ========
Operating income before income taxes decreased substantially for the
three months ended March 31, 1999 from the same period in 1998. This decrease
is primarily attributable to a significant decline in the operating results of
the property and casualty insurance segment. The operating income of the
reinsurance segment also declined, but to a lesser degree. Operating results
were negatively impacted by a substantial decrease in the amount of favorable
development experienced in the actual settlement of claims and changes in
reserves associated with prior years' losses as well as a significant increase
in catastrophe and storm losses.
Premium income increased 8.9 percent for the three months ended March 31,
1999 from the same period in 1998. Both the property and casualty insurance
segment and the reinsurance segment achieved solid growth despite intense rate
competition. The Company continued to experience some signs of rate
stabilization in the first quarter of 1999 as it was able to implement
moderate rate increases in select personal lines of business and on
reinsurance contracts that had been exposed to losses; however, the commercial
lines market, in which the Company conducts the majority of its insurance
business, remained very competitive.
Losses and settlement expenses increased 26.6 percent for the three
months ended March 31, 1999 from the same period in 1998. Both the property
and casualty insurance segment and the reinsurance segment experienced a
substantial decline in the amount of favorable development experienced in the
actual settlement of claims and changes in reserves associated with prior
years' losses and a significant increase in catastrophe and storm losses.
Acquisition and other expenses increased 4.4 percent for the three months
ended March 31, 1999 from the same period in 1998. This increase is primarily
due to the higher production levels noted above.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
Net investment income decreased slightly for the three months ended March
31, 1999 from the same period in 1998. This decrease reflects a decline in
the average rate of return earned on fixed maturity securities, which more
than offset an increase in the average invested balance in these securities.
SEGMENT RESULTS
Property and Casualty Insurance
Operating results for the three months ended March 31, 1999 and 1998 are
as follows:
($ in thousands) 1999 1998
-------- --------
Premiums earned .......................... $ 39,769 $ 36,910
Losses and settlement expenses ........... 31,546 24,904
Acquisition and other expenses ........... 13,144 12,650
-------- --------
Underwriting loss ........................ (4,921) (644)
Net investment income .................... 4,466 4,471
Other income ............................. 347 38
-------- --------
Operating (loss) income before
income taxes ........................... (108) 3,865
Realized investment gains ................ 89 85
-------- --------
(Loss) income before income taxes ........ $ (19) $ 3,950
======== ========
Incurred losses and settlement expenses:
Insured events of the current year ..... $ 34,265 $ 29,069
Decrease in provision for insured
events of prior years ................ (2,719) (4,165)
-------- --------
Total losses and settlement expenses $ 31,546 $ 24,904
======== ========
Catastrophe and storm losses ............. $ 1,211 $ 356
======== ========
Premium income increased 7.7 percent for the three months ended March 31,
1999 from the same period in 1998. Premium growth was experienced in nearly
all geographic areas served by the Company's existing branch structure and
reflects an increase in both the policy count and the average premium charged
per policy. The increase in average premium is attributed to moderate rate
increases implemented in select personal lines of business and controlled
usage of discretionary rate credits in commercial lines of business. Overall
rate adequacy continues to be restricted by the competitive rate environment
and market conditions are not expected to improve significantly in the near
future.
Losses and settlement expenses increased 26.7 percent for the three
months ended March 31, 1999 from the same period in 1998. Results for the
first three months of 1999 reflect a substantial decrease in the amount of
favorable development experienced in the actual settlement of claims and
changes in reserves associated with prior years' losses, an elevated level of
catastrophe and storm losses and an increase in loss frequency. Severe storms
in the month of January produced an estimated $1.75 billion of property damage
for the insurance industry, the third-largest amount of storm losses in the
month of January since 1949 when modern catastrophe-loss record keeping
began.
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
<PAGE>
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
Acquisition and other expenses increased 3.9 percent for the three months
ended March 31, 1999 from the same period in 1998. This increase, which is
attributable to the growth in premium income noted above, was mitigated
somewhat by a decline in profit sharing expenses. These profit sharing
expenses, which take the form of policyholder dividends and contingent
commissions, declined as a result of continued deterioration in the
profitability of the underlying insurance policies.
Underwriting results for the first quarter of 1999 were negatively
impacted by a substantial decline in the amount of favorable development
experienced in the actual settlement of claims and changes in reserves
associated with prior years' losses as well as an elevated level of
catastrophe and storm losses. While significant in themselves, the impact of
these factors was compounded by the intense rate competition that exists
within the insurance industry, especially in the commercial lines of
insurance. Management is working to improve profitability through re-
underwriting programs for both the existing book of business and the agency
force, controlled usage of discretionary rate credits and the implementation
of rate increases where possible.
Reinsurance
Operating results for the three months ended March 31, 1999 and 1998 are
as follows:
($ in thousands) 1999 1998
-------- --------
Premiums earned ............................ $ 9,976 $ 8,778
Losses and settlement expenses ............. 6,921 5,486
Acquisition and other expenses ............. 3,204 3,012
-------- --------
Underwriting (loss) gain ................... (149) 280
Net investment income ...................... 1,703 1,703
Other income ............................... 33 48
-------- --------
Operating income before income taxes ....... 1,587 2,031
Realized investment gains .................. - 4
-------- --------
Income before income taxes ................. $ 1,587 $ 2,035
======== ========
Incurred losses and settlement expenses:
Insured events of the current year ....... $ 5,064 $ 5,699
Increase (decrease) in provision for
insured events of prior years .......... 1,857 (213)
-------- --------
Total losses and settlement expenses $ 6,921 $ 5,486
======== ========
Catastrophe losses ......................... $ 649 $ 163
======== ========
Premiums earned increased 13.6 percent for the three months ended March
31, 1999 from the same period in 1998. This large increase is primarily due
to the addition of two large reinsurance contracts during 1998. Rate
competition within the reinsurance marketplace remained very intense in the
first quarter of 1999. Moderate rate increases were implemented on some
foreign contracts that were exposed to losses in 1998; however, overall rate
adequacy did not improve as rate decreases were experienced on domestic
contracts with good loss experience.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
Losses and settlement expenses increased 26.2 percent for the three
months ended March 31, 1999 from the same period in 1998. This increase is
primarily due to a significant amount of adverse development that resulted
from the actual settlement of claims and changes in reserves associated with
prior years' losses. Much of this adverse development is associated with the
1998 accident year, which experienced heavy catastrophe and storm losses. The
impact of this large increase in adverse development was partially offset by a
considerable decline in losses and settlement expenses associated with the
current accident year.
Acquisition and other expenses increased 6.4 percent for the three months
ended March 31, 1999 as compared to the same period in 1998. This increase is
attributable to the growth in premium income and reflects a decline in
contingent commission expense due to the deterioration in the profitability of
the assumed reinsurance business.
Underwriting results have declined in recent periods, but are still
considered satisfactory in the competitive reinsurance marketplace. The
decline can be attributed in part to rate reductions, which are the result of
excess capacity in the reinsurance marketplace. Employers Mutual is working
to address this issue by accepting a larger share of coverage on desirable
programs and strengthening its relationships with reinsurance intermediaries.
Management is aware of the narrowing profit margin on reinsurance business and
continues to emphasize profitability over premium growth.
Parent Company
Operating income before income taxes declined to $5,000 for the three
months ended March 31, 1999 from $28,000 for the same period in 1998. The
decline is primarily attributable to a lower amount of investment income.
LIQUIDITY AND CAPITAL RESOURCES
The Company maintains a portion of the investment portfolio in relatively
short-term and highly liquid investments to ensure the availability of funds
to meet claims and expenses. The remainder of the investment portfolio,
excluding investments in equity securities, is invested in securities with
maturities that approximate the anticipated liabilities of the insurance
issued.
The Company considers itself to be a long-term investor and generally
purchases fixed maturity investments with the intent to hold them to maturity.
The Company has classified a portion of its investments in fixed maturity
securities, primarily bonds issued by municipalities and corporations, as
available-for-sale securities to provide flexibility in the management of the
portfolio. Unrealized holding gains on fixed maturity securities
available-for-sale, net of tax, totaled $4,945,000 at March 31, 1999 compared
to $6,194,000 at December 31, 1998. Since the Company does not actively trade
in the bond market, such fluctuations in the fair value of these investments
are not expected to have a material impact on the operations of the Company,
as forced liquidations of investments are not anticipated. The Company
closely monitors the bond market and makes appropriate adjustments in
investment policy as changing conditions warrant.
The majority of the Company's assets are invested in fixed maturity
securities. These investments provide a substantial amount of income which
supplements underwriting results and contributes to net earnings. As these
investments mature, the proceeds will be reinvested at current rates, which
may be higher or lower than those now being earned; therefore, more or less
investment income may be available to contribute to net earnings depending on
the interest rate level.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
During the third quarter of 1998 the Company liquidated its common stock
mutual fund portfolio and reinvested the proceeds in individual stock issues
that are being managed on a tax-aware basis. This change in investment
philosophy is not expected to have a material impact on the operations of the
Company as forced liquidations of investments are not anticipated; however,
realized investment gains reported in future periods are expected to decline
significantly from the amounts reported during the last several years as the
Company will have the ability to control both the timing and the amount of
sales that occur in these investments.
The major ongoing sources of the Company's liquidity are insurance
premium income, investment income and cash provided from maturing or
liquidated investments. The principal outflows of cash are payments of
claims, commissions, premium taxes, operating expenses, income taxes,
dividends and investment purchases.
During the first quarter of 1999, the Company generated positive cash
flows from operations of $5,805,437 compared to $10,179,366 for the same
period of 1998. The amount for the first quarter of 1998 includes $5,569,567
received from Employers Mutual in connection with the addition of Farm and
City to the pooling agreement.
On November 20, 1998, the Company's Board of Directors approved a stock
repurchase plan for up to $3,000,000 of the Company's common stock. The
repurchase plan authorizes the Company to make repurchases in the open market
or through privately negotiated transactions. The timing and terms of the
purchases will be determined by management based on market conditions and will
be conducted in accordance with the applicable rules of the Securities and
Exchange Commission. The plan may be terminated at any time at the Company's
discretion. During the first quarter of 1999 the Company repurchased 39,050
shares of common stock at an average price of $11.30 per share.
IMPACT OF YEAR 2000 REMEDIATION ON OPERATIONS
The Year 2000 issue presents both operational and underwriting risks to
the Company. Operational risks include the failure of computer systems and
equipment owned and operated by Employers Mutual, as well as those owned and
operated by vendors and other parties with which the Company conducts
business. Underwriting risks include, but are not limited to, potential
claims by the Company's insureds to recover losses due to interruption of
business or liability to third parties that result from the failure of
computer systems.
Employers Mutual owns and maintains the computer systems utilized in the
operation of the Company's businesses, and is currently in the process of
finalizing changes to these systems in order to be Year 2000 compliant.
Employers Mutual uses a four step process for preparing systems for Year 2000
compliance:
1) Inventory and impact - systems are reviewed to assess the impact
of Year 2000, including the consequences of failure to achieve
Year 2000 compliance.
2) Planning and scheduling - modifications are planned and
scheduled.
3) Modification and testing - necessary system modifications are
made and tested.
4) Certification - a formal test of the system for compliance and
approval by the appropriate management personnel.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
All critical systems, including policy issuance, billing and claims
processing, have been certified as compliant. The majority of the non-
critical systems are also completed. Work on the few remaining systems not
yet completed is near completion of the four step process for Year 2000
compliance, with all remaining work scheduled for completion in the first half
of 1999. Employers Mutual has contacted its vendors of computer and facility
equipment and software to ascertain whether those systems are Year 2000
compliant. All necessary upgrades to the equipment and software to achieve
Year 2000 compliance have been scheduled for implementation by the first half
of 1999. Employers Mutual has also contracted with an outside consulting firm
to provide an independent assessment of Year 2000 compliance efforts. The
consultants issued a report which included findings and recommendations. This
information has all been considered by management in its assessment of Year
2000 compliance issues.
Employers Mutual is also monitoring Year 2000 compliance of third parties
with which it has a material business relationship. Employers Mutual has
contacted financial institutions providing custodial and other services and
suppliers to ascertain their Year 2000 compliance status. The Company is
relying upon the Year 2000 readiness statements of these third parties and has
not independently verified the accuracy of such statements.
The Company has distributed a letter to all of its commercial insureds
notifying them that their current policies do not cover Year 2000 losses, but
that coverage may be available through an endorsement to the policy. A
questionnaire has been developed and provided to them to aide in assessing
potential risks from Year 2000 noncompliance. Employers Mutual has in place
reinsurance protection for potential third party liability claims against
policyholders arising from Year 2000 issues.
Year 2000 compliance efforts have been in process for a number of years.
The majority of the costs associated with these efforts is the internal
payroll and payroll related expenses of the information systems department.
These expenses were charged to operations in the year incurred and were not
separately tracked. In addition, nearly all purchases of software and
hardware applications were not made specifically for Year 2000 compliance, and
are not considered costs of the Year 2000 compliance effort. Costs incurred
to date for outside consultants and software and hardware applications
specifically purchased for Year 2000 compliance efforts have amounted to less
than $100,000 for the EMC Insurance Companies. The Company's share of all
remaining costs associated with the Year 2000 compliance project are not
expected to exceed $50,000.
The most likely worst case scenario for failing to achieve Year 2000
compliance would be a delay in processing of non-critical functions. Due to
the current state of readiness, it is unlikely that the processing of policy
issuance, billing, or claim handling activities will be delayed. However, it
is reasonably likely that delays in the processing of ancillary activities may
be experienced. The effect of these delays are not expected to be material to
the Company's results of operations, liquidity, or financial condition.
The Company believes it has addressed the potential exposures related to
Year 2000 noncompliance. If an unforeseen Year 2000 failure occurs, manual
processing may be used until the necessary corrections are implemented. In
addition, data on the computer systems is regularly backed-up and held off-
site in both soft and hard copy format. This historical data would be
available in the event of any processing failures. A formalized and
documented business continuation plan is also in place to support operations
in cases of business interruption.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial
- ------- -------------------------------------------------
Condition and Results of Operations, Continued
----------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities", effective for
fiscal years beginning after June 15, 1999. Currently, the Company's
investment strategy does not include investments in derivative instruments or
hedging activities. Adoption of this statement is not expected to have any
effect on the operating results of the Company.
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides issuers the
opportunity to make cautionary statements regarding forward-looking
statements. Accordingly, any forward-looking statement contained in this
report is based on management's current expectations and actual results of the
Company may differ materially from such expectations. The risks and
uncertainties that may affect the actual results of the Company include but
are not limited to the following: catastrophic events and the occurrence of
significant severe weather conditions; state and federal legislation and
regulations; rate competition; changes in interest rates and the performance
of financial markets; the adequacy of loss and settlement expense reserves,
including asbestos and environmental claims; failure in Year 2000 compliance
by the Company, its vendors or third party service providers; and other risks
and uncertainties inherent in the Company's business.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 3. Quantitative and Qualitative Disclosures About Market Risk
- ------- ----------------------------------------------------------
The main objectives in managing the investment portfolios of the Company
are to maximize after-tax investment income and total investment return while
minimizing credit risks, in order to provide maximum support for the
underwriting operations. Investment strategies are developed based upon many
factors including underwriting results and the Company's resulting tax
position, regulatory requirements, fluctuations in interest rates and
consideration of other market risks. Investment decisions are centrally
managed by investment professionals and are supervised by the investment
committees of the respective boards of directors for each of the Company's
subsidiaries.
Market risk represents the potential for loss due to adverse changes in
the fair value of financial instruments. The market risks of the financial
instruments of the Company relate to the investment portfolio, which exposes
the Company to interest rate and equity price risk, and to a lesser extent
credit quality and prepayment risk. Monitoring systems and analytical tools
are in place to assess each of these elements of market risk.
Interest rate risk includes the price sensitivity of a fixed maturity
security to changes in interest rates and the affect on future earnings from
short-term investments and maturing long-term investments, given a change in
interest rates. The following analysis illustrates the sensitivity of the
Company's financial instruments to selected changes in market rates and
prices. A hypothetical one percent increase or decrease in interest rates as
of March 31, 1999 and December 31, 1998 would result in corresponding pretax
decreases or increases in the fair value of the fixed maturity portfolios of
approximately $17,000,000 or 4.1 percent at March 31, 1999 and $16,000,000 or
3.9 percent at December 31, 1998. In addition, a hypothetical one percent
increase or decrease in interest rates at March 31, 1999 and December 31, 1998
would result in corresponding increases or decreases in pretax income over the
next twelve months of approximately $800,000 from March 31, 1999 and $800,000
from December 31, 1998, assuming the current maturity and prepayment patterns.
The Company monitors interest rate risk through the analysis of interest rate
simulations, and adjusts the average duration of its fixed maturity portfolio
by investing in either longer or shorter term instruments given the results of
interest rate simulations and judgments of cash flow needs.
The valuation of the Company's marketable equity portfolios is subject to
equity price risk. In general, equities have more year-to-year price
variability than bonds. However, returns from equity securities over longer
time frames have been consistently higher. The Company invests in a
diversified portfolio of readily marketable equity securities. A hypothetical
10 percent increase or decrease in the S&P 500 as of March 31, 1999 and
December 31, 1998 would result in corresponding pretax increases or decreases
in the fair value of the Company's equity portfolio of approximately
$2,900,000 at March 31, 1999 and December 31, 1998.
The Company invests in high quality fixed maturity securities, thus
minimizing credit quality risk. At March 31, 1999 the portfolio of long-term
fixed maturity securities consists of 23.9 percent U.S. Treasury, 15.8 percent
government agency, 6.3 percent mortgage-backed, 41.8 percent municipal, and
12.2 percent corporate securities. At December 31, 1998 the portfolio of
long-term fixed maturity securities consisted of 24.5 percent U.S. Treasury,
13.3 percent government agency, 6.8 percent mortgage-backed, 42.1 percent
municipal, and 13.3 percent corporate securities. No securities are below
investment grade.
<PAGE>
EMC INSURANCE GROUP INC. AND SUBSIDIARIES
Item 3. Quantitative and Qualitative Disclosures About Market Risk,
- ------- -----------------------------------------------------------
Continued
---------
Prepayment risk refers to the changes in prepayment patterns that can
either shorten or lengthen the expected timing of the principal repayments and
thus the average life and the effective yield of a security. Such risk exists
primarily within the portfolio of mortgage-backed securities. The prepayment
risk analysis is monitored regularly through the analysis of interest rate
simulations. At March 31, 1999 the effective duration of the mortgage-backed
securities is 1.9 years with an average life and current yield of 3.8 years
and 7.6 percent, respectively. At December 31, 1998 the effective duration of
the mortgage-backed securities was 1.5 years with an average life and current
yield of 2.1 years and 7.7 percent, respectively.
PART II. OTHER INFORMATION
- -------- -----------------
Item 6. Exhibits and Reports on Form 8-K
- ------- --------------------------------
(a) None.
(b) No Form 8-K was filed by the registrant during the
quarter ended March 31, 1999.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EMC INSURANCE GROUP INC.
Registrant
/s/ Bruce G. Kelley
-------------------------
Bruce G. Kelley
President & Chief Executive Officer
/s/ Mark Reese
--------------------------
Mark Reese
Vice President and
Chief Financial Officer
Date: May 14, 1999
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the 3/31/99
balance sheet and income statement and is qualified in its entirety by
reference.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 217,206,384
<DEBT-CARRYING-VALUE> 165,018,119
<DEBT-MARKET-VALUE> 175,735,444
<EQUITIES> 31,854,245
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 439,579,126
<CASH> 1,219,682
<RECOVER-REINSURE> 17,185,736
<DEFERRED-ACQUISITION> 12,397,747
<TOTAL-ASSETS> 498,043,475
<POLICY-LOSSES> 249,215,264
<UNEARNED-PREMIUMS> 61,024,651
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 1,793,390
<NOTES-PAYABLE> 0
0
0
<COMMON> 11,470,548
<OTHER-SE> 150,180,988
<TOTAL-LIABILITY-AND-EQUITY> 498,043,475
49,744,614
<INVESTMENT-INCOME> 6,269,253
<INVESTMENT-GAINS> 89,288
<OTHER-INCOME> 769,077
<BENEFITS> 38,466,995
<UNDERWRITING-AMORTIZATION> 11,735,899
<UNDERWRITING-OTHER> 4,140,342
<INCOME-PRETAX> 1,572,517
<INCOME-TAX> (209,226)
<INCOME-CONTINUING> 1,781,743
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,781,743
<EPS-PRIMARY> .15
<EPS-DILUTED> .15
<RESERVE-OPEN> 245,610,323
<PROVISION-CURRENT> 39,329,399
<PROVISION-PRIOR> (862,404)
<PAYMENTS-CURRENT> 7,751,508
<PAYMENTS-PRIOR> 27,884,336
<RESERVE-CLOSE> 249,215,267
<CUMULATIVE-DEFICIENCY> (862,404)
</TABLE>
